Active Investor

The Misbehavior of Investors

Active Investor
“The investor’s chief problem, and even his worst enemy, is likely to be himself.” – Benjamin Graham, 1949, The Intelligent Investor


There was initial hesitation in choosing to use Mr. Graham's age-old adage. To say that we have used this quote many times would be an understatement, but it is very fitting for the following topic.

DALBAR, a Boston based consulting firm, just released its annual Quantitative Analysis of Investor Behavior (QAIB) study and concluded that there continues to be a widely misinformed population about investing. According to the study, the average equity investor in aggregate had underperformed the S&P 500 by approximately 8 percentage points per year for the last 30 years! This means that the average investor in equity mutual funds was only successful at capturing 34% of the broad market benchmark returns. The results were even worse for bond mutual fund investors with the Barclays’ Aggregate Bond Index, which had a 5.97% annualized return, delivering about 5 times what the average bond fund investor took home, which was 1.16%. This meant that the average bond fund investor only captured 19% of the bond benchmark returns. 

DALBAR attributes the continued underperformance to investors selling in panic after market downturns and buying after the blissful market surges – the exact opposite of investors who would apply proper investing discipline and rebalance their portfolios. The compounding effect of this behavior has been very costly to the average investor. The table below shows the performance of the average equity mutual fund investor versus 1-Year US Treasury Notes, the S&P 500 index, and the IFA Index Portfolio 100 in both annualized return and the growth of $100,000 over the 30 years from 01/01/1985 to 12/31/2014. If you were to factor in taxes, transaction costs and inflation (a total of approximately 4% per year), the average equity fund investor earned nothing at all. Investors often focus their attention on mutual fund and advisor fees, but this behavioral gap in annualized returns swamps any impact of fees.

We aren’t sure which hurts more: the fact that most investors would have done better by just investing in 1-Year US Treasury Notes, or, the close to $3,000,000 they have left on the table versus $100,000 properly invested in a globally diversified portfolio of equity index funds that was tilted towards the dimensions of higher expected return (IFA Index Portfolio 100).

To point out an issue and not provide a solution is of no help to anyone. And to simply say, “buy, hold and rebalance a portfolio of index funds,” does not address the real problem at hand. Let’s start with a very basic proposition that applies to everyone; two heads are better than one.

Having a knowledgeable and experienced coach, doctor, lawyer, accountant or wealth advisor guiding you towards your goals and objectives usually leads to better outcomes. IFA's business is not just about managing investments; it is also about guiding and advising investors on how to best capture the returns that are there to be earned. Our book, Index Funds, is focused on the proper investor behavior. IFA also provides wealth services that cover the full spectrum of investor needs. From investment advice to financial planning for retirement, social security or college funding, or to referrals for estate planning, insurance advice, trustee services, or charitable giving accounts. And maybe even more importantly, we are there to provide investor education and a calm and prudent perspective during the good times and the bad times. 

Keeping investors committed to the plan during the bad times is where our job is most valuable. The proof of our commitment to our investors is in the pudding. We published an article last October that summarized an internal study conducted by IFA’s Risk Management team. It concluded that most of our clients followed IFA's advice, stayed the course and did an absolute 36% better at capturing the returns of their original index portfolio than those that did not follow IFA's advice. The chart below summarizes the results.

The simple fact that DALBAR continues to publish the QAIB study every year with virtually the same poor results makes Benjamin Graham’s most famous quote more applicable than ever. As investment professionals, this study has been an annual reminder for the last 16 years that our advice (see our 12-Steps) can have a substantial impact on the financial security of many investors.